FEATURE ARTICLE: THE GLOBAL FINANCIAL CRISIS AND ITS IMPACT ON AUSTRALIA

This article was contributed by the Reserve Bank of Australia.

The first signs of distress in financial markets emerged around the middle of 2007 when two funds related to US financial company Bear Stearns announced serious problems with their holdings of mortgage-backed securities (MBS). The problems were particularly acute in the case of securities containing sub-prime mortgages, which are mortgages to individuals with a non-standard credit history or on lower incomes.

The dislocation spread through credit markets over the second half of 2007 as concerns intensified about the value of mortgage-backed securities and other asset-backed securities. Securities which had been thought by investors to be low-risk were downgraded sharply as assets underlying those securities suffered very sharp losses. These concerns caused banks to become considerably less willing to lend to each other and to hoard their cash holdings. As a result, interest rates in money and credit markets rose and parts of credit markets started to malfunction. Equity markets took longer to be affected, with prices continuing to rise until late in the year, even as bank share prices started to decline.

These tremors ebbed and flowed over subsequent months, intensifying in March 2008 when Bear Stearns effectively collapsed and was rescued by JP Morgan. The financial crisis then reached its zenith in September 2008 when US securities company Lehman Brothers went into bankruptcy, and the large insurance company AIG was rescued by the US Government along with the two large mortgage agencies, Fannie Mae and Freddie Mac.

The Lehman bankruptcy saw many parts of global financial markets come to almost a complete halt and fears arose about the stability of the global financial system. Governments and central banks responded to these developments with a large and wide-ranging policy response, including sizeable fiscal stimulus, large reductions in policy interest rates, guarantees of bank deposits and bank debt issuance, and in some cases, sizeable government ownership of troubled financial institutions.

Reflecting the impact of these policy responses, conditions in financial markets improved over the course of 2009 as risk aversion has abated. Share markets have recovered around one half of their declines, credit markets have gradually begun to reopen and function more normally.

The effect of the crisis on Australia has been considerably less than in many other countries. The Australian economy has recorded markedly better growth outcomes than most other developed economies, many of which have experienced severe recessions and rises in unemployment. The Australian financial system has been markedly more resilient. Notably, Australian banks have continued to be profitable and have not required any capital injections from the Government.

That said, the local economy and financial markets have not been immune. Growth in the economy slowed to around half a per cent and the unemployment rate has risen by nearly two percentage points to around 5¾ per cent by November 2009.

The most obvious impact of the financial crisis on most Australian households was the large decline in equity prices, which reduced the wealth of Australian households by nearly 10 per cent by March 2009. However, since the trough in equity markets in March 2009, the local market had recovered half of its decline by the end of November 2009.

The Australian dollar also depreciated rapidly and sizeably as the crisis intensified, declining by over 30 per cent from its July 2008 peak. Around the time of the Lehman bankruptcy, conditions in the foreign exchange market were particularly illiquid, prompting the Reserve Bank of Australia (RBA) to intervene in the market to enhance liquidity. Since March 2009, as fears abated, the Australian dollar largely recovered, reflecting the relative strength of the Australian economy.

The credit and money markets in Australia have also proven to be more resilient than in many other countries, necessitating considerably less intervention by the RBA than occurred in many other countries. In large part this reflected the health of the Australian banking system. The Australian banks had almost no holdings of the “toxic” securities that severely affected other global banks. The health of the Australian banking system facilitated the effectiveness of the monetary and fiscal response, particularly by allowing much of the large easing in monetary policy to be passed through to interest rates on loans to households and businesses, in stark contrast to the outcome in other developed economies.

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